6 October 2003
1 October 2001
29 March 2010
4 January 2013
18 June 2007
27 January 2003
Rogues abound, and the form that white collar crime takes may vary with developments in the business environment, but the categories of wrongdoing outlast the methods: diverting remittances from debtors; misappropriating cash sales; creating false expenses; inserting dummy names on payrolls; selling off stock on the side. The list goes on and on.
Unlike the above, which are simply variants of theft, much white-collar crime, particularly in a challenging economic climate, is designed not to enrich the perpetrator directly, but rather to keep the enterprise going by showing false accounts to the bank until they are on an 'even keel' again. Unfortunately that rarely happens.
Indeed, many of the greatest frauds perpetrated by senior management begin as devices just to plug a 'temporary' difficulty. Diluting the impact of the fraud through legitimate trading invariably proves to be far too problematic.
A major UK training company had a publishing division that produced study manuals for use by students at every stage of their examinations. The division operated as a separate limited company with two directors who exploited their apparent autonomy by putting their wives on the payroll and on handsome salaries. No one noticed, so they devised a plan for more generous enrichment.
The study manuals were exported to local colleges and universities in many parts of the world, notably Africa, the Far East and the Caribbean. By colluding with a senior person in each such college, the documentary returns recording class sizes (and hence the orders for study manual requirements) were contrived to show about 50 per cent of the volumes actually exported.
The balance was sold off through local bookstores and the proceeds shared by the conspirators. Again, the directors exploited their hands-on ability to fake the print-run records so that everything tallied. They and their families also enjoyed holidays in a number of exotic destinations put through the books as business trips.
About £1.5m later, they grew careless about covering their tracks and a new administrative recruit raised some penetrating queries about the gap between export records and books paid for. An investigation, full confessions and partial restitution followed, but the company and its fidelity insurers lost heavily.
The false accounting variety of white collar crime is exemplified by the shenanigans of the directors of a once-prosperous West Country family company producing bottled fruit drinks for own-brand supermarket chains. The directors' personal extravagance and the largesse of their hospitality were legendary, and they enjoyed it too much to recognise when the business could no longer afford their lifestyle. The family-constituted board had taken its eye off the commercial ball.
Cash flow, ever the infallible indicator, caused anxiety at the bank. The finance director - the accountant member of the family - bolstered the management accounts by faking the stock figures to show improved current period profitability. Six months later, when the profits failed to be matched by cash flow, the bank foreclosed and the family enterprise, after a 200-year history, met its predictable nemesis on the receiver's block.
Comparable accounting tricks are sometimes resorted to in anticipation of the sale of the business. In one instance the completion accounts failed to reflect massive management bonuses that were based on the final period profits. Although their precise sum was not known, the bonuses had already been committed. The accounts also included a write-back to profits of debts written off as irrecoverable two years earlier and profit on the sale, to a friendly local grain-crusher, of the company's own clapped-out grain-crushing machine at 10 times its worth. The subsequent action for fraudulent misrepresentation finished up in the civil rather than criminal courts and the restitution award cost the vendors millions.
Deceiving the banks
Crimes against banks and other financial institutions can be equally colourful. A vendor of fairground equipment in Ireland sold his various riding machines to circus and fairground operators on hire purchase contracts, which he then sold on to two major finance companies. He tested the finance companies' controls by selling them a few fake HP contracts on which he kept up the payments for a while. Despite six-monthly inspections the scam remained undetected, so he expanded its scale until he had 'sold' more fairground equipment than there were fairs in the Northern hemisphere. He gave up the fraud only when it outgrew his computer's ability to tell him which sales were fictitious and which were genuine. He confessed the whole saga to his incredulous auditor, and asked him to sort out the mess with the authorities.
Book debts are just as susceptible to abuse. What began simply enough in one case as an attempt to impress the bank by generating false sales to demonstrate strong growth, finished up as a major invoice discounting fraud. It came to light only when the bank, by then exposed to the tune of more than £5m, contacted debtors directly to find out why they had not paid, only to find that some of them did not exist and others were not even customers. Prosecutions went to trial and the malefactors, on pleading guilty, were given suspended sentences. There were no recoveries.
The audit role
The discovery of such criminal escapades is usually followed by the cry of 'where were the auditors?' The role of auditors in detecting white collar crime is often poorly misunderstood by investors, creditors and the business community generally. Indeed, it is poorly understood by auditors.
Broadly, audit procedures are designed to detect material mis-statements in financial statements. For a mis-statement to be considered material it must be capable of affecting the decision-making process of any legitimate user of those accounts for any legitimate purpose, although investment decisions by an individual shareholder would not normally be covered following case law, which dictates that the auditor's duty of care is to the body of the shareholders taken as a whole.
However, auditors are unlikely to succeed with a defence that relies on the materiality threshold alone. If the audit procedures were inherently inadequate or poorly performed, and were hence incapable of detecting any fraudulent activity, material or otherwise, auditors are likely to be held responsible at least in part. No doubt they will plead contributory negligence on the part of the management, whose prime responsibility is to safeguard the company's assets by designing controls for this purpose. Undetected fraud, by definition, represents a manifest failure of such safeguards, but the criminal breach of safeguards by those who designed them is a possibility that the auditors should have in contemplation when they plan their tests.
It is sometimes argued by auditors that as long as the actual assets balances are correctly reflected in the financial statements, a true and fair view is given, notwithstanding that those balances would have been somewhat greater had the fraud not occurred, or had it been detected and hence curtailed much earlier.
Such an argument is unlikely to succeed. A set of accounts that fails to reflect, as a profit and loss account charge, the extent of material depredations by senior management can hardly be considered to be both true and fair. Disclosure is sometimes embarrassing - no board likes to admit that it has been criminally suckered by one or more of its senior people acting in collusion, but it provides an opportunity to signal renewed determination to enforce safeguards and to minimise temptations in the future.
The origins of auditing are, of course, associated with fraud detection, but the more reasoned approach outlined above is now accepted. Linking the non-detection of fraud to audit failure as a knee-jerk response must be resisted. The focus of statutory audits is the truth and fairness of the accounts as a whole and a well-designed and well-executed fraud by senior executives working, for example, in concert with third parties, may well escape detection by even the most rigorous audit.
Risk management procedures
If risk management is to be effective, no one should fall outside the strictures of the procedural rulebook, no matter how senior they may be. The breach of basic principles takes many forms, but the dynamic, quick-witted, utterly plausible, sociable, generous senior executive should be subject to the controls in force, just like anyone else. If they need an extra signature on a cheque, the supporting documents must be produced, whatever the supposed urgency.
The majority of all white collar crimes would have been terminated in their infancy if those not implicated had retained a modicum of circumspection and remained vigilant.
Emile Woolf is head of forensic accountancy at chartered accountants Kingston Smith